✒️#14 - State of the innovation industry

The world is different now. Where does innovation stand?

Feb 28, 2022

Good morning!☀

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Here's your weekly roundup of the most interesting things I've read, learned, or listened to. I write about the people and funds that can create a better world for us.

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♻️Assessing the resilience of the world’s innovation engine

I wrote last week about the likelihood of interest rate hikes not scaring LPs. I wrote a few weeks ago about how VCs don’t expect the IPO party to stop. Since both of those essays, the world has become increasingly volatile and people still don’t know how the “pandemic vintage” of start-ups will perform in the face of lockdowns, stimulus, inflation, and now war.

Abraham Thomas wrote an excellent essay about what a Minksy Moment in venture capital could look like. The term is named after Hyman Minsky, who’s best known for his explanation of the boom and bust cycles of public markets. In short, a Minsky Moment is when a boom supported by a positive-reinforcement cycle bringing in new capital suddenly sees that new capital infusion slow, and everything implodes with the positive reinforcement cycle going in the other direction. In start-ups, think: a company has a down round, common shareholders are wiped out, start-up perceived as damaged, customers churn, employees leave, new employees are more expensive because startup is “damaged”…on and on. A key question as more money enters the start-up ecosystem is are we getting toward “alpha decay” in start-ups that will spark this Minksy Moment: knowledge spreads, technology diffuses, and arbitrages disappear. Markets asymptote towards ever-greater efficiency.

Thomas points to the VC “J-curve” - the typical return curve of VC funds where the initial period shows negative IRR because start-ups fail fast, but are then made up for by the big winners later on. Thomas argues correctly that VC fund returns are getting past the early negative portion of their “J-curve” faster, making them seem less risky and enticing more capital. While the time compression is certainly true, LPs looking at VC returns compared to funds today instead of funds 2-3 years ago should be able to benchmark on a relative basis.

Where Thomas refreshingly leaves his essay is “we just don’t know.” We could go one of two ways here. We could see a start-up perceived as safe fail, causing a scare in the industry, people pulling out money, more start-ups failing, etc. Or maybe start-ups are so valuable now because they provide so much value. We could see one start-up fail, and others quickly fill in its place because our start-up and talent ecosystem is so much more robust now.

So far so good? Share me with your besties:

🧐Defense tech

Defense tech has gotten a lot of flack for putting innovation dollars toward weapons and national lethality. In light of ongoing Russian aggression, what has unfolded in Ukraine, and what might be headed for more of Europe and other US allies, sentiment is quickly moving the other direction.

First, why is defense tech a thing? War is shifting from the physical battlefield to the digital one (for more on this, read anything by Jacob Helberg). Before Russia physically invaded and bombed Ukraine, power grids were hacked, radar arrays were locked down, and anti-aircraft weaponry was sabotaged. All before a Russian foot stepped into Ukraine.

Josh Wolfe @wolfejosh

3/ LIVE updates —Ukranian radar arrays + anti-aircraft TECH destroyed —pressure from multiple vectors + fronts on north, east and south…

nytimes.comPutin’s Forces Attack UkraineUkraine’s government said it faced “a full-scale attack from multiple directions.” World leaders condemned President Vladimir Putin’s actions.

Ok, so now what is defense tech? The sector is composed of companies like:

Anduril - creating autonomous defense hardware built off its LatticeOS.
Vannevar Labs - named after Vannevar Bush, who before founding Raytheon oversaw almost all wartime R&D during WWII including development of radar and initial stages of the Manhattan Project. The CEO recently penned How to build defense products, which provides an exceptional overview of the space.
Galvanick - creating a security infrastructure for major industrial operations.

These companies are building specifically to enhance lethality of the United States, improve our defenses, or increase deterrence.

So who are the customers? In most cases, there’s just one: the Department of Defense. This is good and bad. Good because DoD has a massive budget and lots of modernizing to do. But bad because meaningful government contracts are difficult to obtain with any speed. This is not like B2B selling into an enterprise. While there is lots of money, Silicon Valley investors’ patience has wained as start-ups vie for these long term contracts. Recent events may revive that patience.

I’ll leave with this story. Over the weekend, Russia knocked out much of Ukraine’s internet. The Vice PM of Ukraine tweeted at Elon Musk to ask for help. In response, Musk sent satellites over Ukraine to revive internet access via SpaceX’s Starlink. Another way to support allies without direct conflict.